October 2009 - (Lang Michener LLP Corporate Insurance Brief)

Lang Michener LLP Corporate Insurance Brief Fall 2009. Also published in International Law Office under the title "Insurance Company Mergers: A Regulatory Guide," May 26, 2009.Also published by ABA Section of Anti-trust Law, Insurance Industry Committee, The Insurance Policy Newsletter, Winter 2009.

Canada, like many jurisdictions, has had an insurance marketplace characterized, in large part, by a significant number of competing companies in various lines of business. Over the last number of years, however, consolidation has proceeded in the insurance industry in Canada, such that in at least some lines of the business, the marketplace is becoming moderately consolidated. Given current pressures on the financial marketplace the trend may be expected to continue. In this note we seek to outline the regulatory issues relevant to insurance mergers, particularly in a consolidating marketplace.

Insurance mergers in Canada are subject to specific review under the insurance and banking regimes. Mergers of "large" insurers are subject to additional regulation. As well, acquisition of insurance companies by foreign entities may be subject to review under the Investment Canada Act regime. Finally, the Canadian Competition Act contains merger control provisions.

Unlike in the United States, in Canada the federal government and the provincial governments each have the power to incorporate and thus regulate corporate proceedings (including mergers) of insurance companies. The vast majority of insurance companies are governed by the federal Insurance Companies Act and this Act deals extensively with mergers. If insurance companies are incorporated under provincial jurisdiction, the insurance legislation of that province will guide the merger process. While the marketplace regulation of insurance is an exclusive provincial power, these provisions are not material to mergers.

The provisions of the federal and provincial laws are both substantive and procedural, dealing with notification requirements. This short note provides a brief overview of each of these regimes as they apply to insurance mergers in Canada.

II. Financial Institution Merger Review

(i) Federal Review Acquisition of more than 10% of the voting control of a federally incorporated insurance company requires the approval of the Minister of Finance under the Insurance Companies Act.1 Typically in such reviews the Minister considers the experience, reputation, regulatory standing and financial strength of the acquirer and will, among other things, require the acquirer's ultimate parent to provide a non-binding support letter regarding the insurer. The acquirer also must provide a three-year business plan for the target, including projected solvency margins. Finally, the acquirer must describe the reasons for and the benefits of the acquisition. If these "benefits" include streamlining and attendant job losses, these will need to be addressed. The process normally starts with a meeting with the regulator, involves providing a lot of information and normally takes anywhere from three to six months.

Secondly, if the acquirer of 10% or more of the voting shares in an insurance company is a "foreign bank" as defined in the Bank Act, such transaction needs the approval of the Governor in Council (i.e., the Federal Cabinet).2 Here, the review focuses on plans for the acquirer and its Canadian investments to get into the banking industry (i.e., taking deposits and providing credit). This review is normally carried out in parallel with the Ministerial application under the Insurance Companies Act, discussed in the preceding paragraph, and does not normally add significant time to the approval process.

If two or more insurance companies incorporated under the Insurance Companies Act seek to merge, they must have the amalgamation agreement approved by the Superintendent of Financial Institutions. This agreement must be accompanied by the report of an independent actuary. After approval is received from the Superintendent of Financial Institutions, the amalgamation agreement must be approved by the insurance companies' shareholders, policyholders or members. An application must then be made to the federal Minister of Finance, who will assess the rationale for the amalgamation; the financial statements and projections of each of the amalgamating companies; sources of continuing financial support for the amalgamated company; the business record of the companies and their corporate leadership; and an integration plan, with a view to ensuring that the transaction is in the best interests of the Canadian financial system.3

If, instead of acquiring shares in a federal insurance company, the acquirer purchases assets by way of an insurance portfolio, the Minister of Finance must approve the acquisition4. The usual method of asset acquisition is by way of assumption reinsurance, although for small, discrete portfolios, novation is sometimes possible. The Ministerial review will assess the impact of the acquisition on the policyholders of both the acquirer and the target company. This review requires the submission of pro-forma financial statements; a three-year business plan including projected solvency margins; and, in the case of life insurance and business having a lengthy tail, the report/opinion of an independent actuary addressing the effects on the policyholders of both companies. The acquirer must also ensure that it has the authorizations for the classes of business being acquired. Again, the approval process normally takes between three and six months, depending in part on how diligently the required documentation is assembled and submitted. As in the case of share acquisitions, the process includes mandatory publication requirements and entitles policyholders to object, which they occasionally do. If the regulator considers the objections to have any merit, it will require the companies to address them, which can add significant delays to the process and may require modifications to the acquisition.

Finally, if a foreign bank acquires assets, rather than shares, Federal Cabinet approval is again required, and the review will focus on the same factors as those under a share acquisition.

(ii) Provincial Review In the case of a portfolio transfer, the acquirer must also ensure that it has the requisite provincial licenses for the classes of insurance in each of the provinces/territories where policyholders of the target portfolio reside. In the past, provinces processed licence applications in parallel with the federal authorizations, but now a number of provinces require the federal authorizations to be in place before they accept applications, which can add several months to the overall approval process.

In addition to these rules respecting federal insurance companies, those insurance companies incorporated provincially are generally subject to similar provincial approval requirements. As mentioned in the introduction, however, there are relatively few such companies, and thus mergers and portfolio acquisitions involving them are relatively rare. Accordingly, the provincial approval process is much less well defined and, therefore, involves even more interactions with the provincial regulators. All of these requirements are aimed generally at ensuring the soundness of the financial system, rather than competition or antitrust-related considerations.

III. Investment Canada Act

The Investment Canada Act requires that the Government of Canada be notified of acquisitions of Canadian businesses – including insurance companies – when the assets of the business exceed five million dollars in value and the acquirer is a foreign-controlled company. This will capture virtually any insurance company acquisition, but the notification obligation is not onerous – it is a brief two-page report that must be filed within thirty days after closing of the transaction.

In addition to the notification requirement, which applies to all covered transactions, larger transactions subject to the Investment Canada Act must obtain government approval in advance. The asset threshold for approval changes each year with inflation, but for the 2009 year, and for investors from most countries in the world (i.e., members of the WTO), the level is set at C$312 million. For insurance companies, this threshold is relatively easy to exceed. Amendments to the Investment Canada Act, which were very recently passed by Parliament, and are likely to come into effect sometime prior to the end of 2009, will increase the threshold to C$600 million (and then to C$1 billion in two years). These higher thresholds will be based on "enterprise value", which is a concept not defined in the legislation (it will be defined via regulation), but for publicly traded companies it is likely equivalent to total market value. Even with these higher thresholds, however, a number of insurance acquisitions are expected to exceed the limits and require government approval.

Assuming there are no issues of "national security" arising from a proposed acquisition, and that the transaction requires approval, the government has 75 days (an initial 45 days plus 30 days, if more time is needed) to review the proposed transaction. It is worth noting that a new system for reviewing transactions that may injure "national security" is a major part of the 2009 amendments to the Investment Canada Act.

Historically, approval under the Investment Canada Act has virtually always been obtained, but in order to achieve approval, firms typically have to give undertakings to the government, addressing issues such as level of employment, Canadian management, head-office activity in Canada, purchases in Canada, research and development, and the like. These undertakings are typically required to be in effect for a period of three years, post closing.

There are some exemptions relevant to insurance transactions under the Investment Canada Act. These exemptions will not avoid application of the about-to-be-enacted rules by which the Canadian federal government will be empowered to declare a transaction to be potentially injurious to national security. However, it seems unlikely this regime would be applied to an insurance transaction.

The first exemption is found in Section 10(1)(h) of the Investment Canada Act, which establishes an exemption for certain banking-related transactions. That section provides that the Investment Canada Act does not apply to "any transaction to which Part XII.01 of the Bank Act applies." Part XII.01 states that the Investment Canada Act does not apply to five categories of transactions:

Insurance Companies Act. Bank Act Bank Act

When there is an acquisition by a foreign business, one must determine if that acquirer is "an entity associated with a foreign bank" to decide if any of the above-listed exemptions apply.

The second exemption is found in Section 10(1)(j) of the Investment Canada Act, which establishes an exemption for the acquisition of control of a Canadian business by:

The exemption defined by section 10(1)(j) of the Investment Canada Act deals with situations involving purchasers that are insurance companies incorporated in Canada, non-resident insurance companies approved to insure risks in Canada, and corporations incorporated in Canada that are wholly controlled by either of these categories of insurance companies.

The exemptions are not open-ended. For Canadian-incorporated insurance companies, the exemption applies only "on a condition that the gross investment revenue with a company from the Canadian business is included in computing the income of the company under section 138(9) of the Income Tax Act."

Non-resident insurance companies, in addition to being approved under Part XIII of the Insurance Companies Act, must also have their gross investment income included in the computing of income of the company under section 138(9) of the Income Tax Act. Additionally, the voting interest of the entity carrying on the Canadian business, or the assets used in carrying on the Canadian business, must be vested in trust under that section of the Income Tax Act.

Finally, corporations controlled by one of these classes of insurance companies must vest in trust assets used in carrying on the Canadian business, pursuant to Part XIII of the Insurance Companies Act.5

IV. Competition Act

In addition to specific insurance or financial-system review and foreign-ownership review, the Competition Act's merger provisions apply to acquisitions of insurance companies, as they apply to acquisitions of any other business.6 The Competition Bureau will not typically consider soundness of the financial system as relevant in reviewing a merger; rather it will apply the test set out in Section 92 of the Competition Act. That test is whether the merger (defined as the acquisition of control over a significant interest in the whole or part of a business of another person) prevents or lessens, or is likely to prevent or lessen, competition substantially.

The Commissioner of Competition has released Merger Enforcement Guidelines,7 which indicate that, as a general rule, if the merger does not give rise to a competitor (a) with more than a 35% market share in a relevant market, or (b) with more than a 10% market share in circumstances in which the top four firms account for more than 65% of the relevant market, then the transaction is unlikely to be challenged. Even above those thresholds, however, transactions are frequently not challenged. Given the historic, relatively un-concentrated nature of the Canadian insurance sector (although it is becoming more concentrated), insurance-company mergers have not given rise to serious Competition Act challenges in Canada. At some point, however, that may change as the sector continues to consolidate.

In addition to substantive merger control, the Competition Act also requires pre-notification for mergers exceeding certain size thresholds. Due to the nature of the insurance business, most transactions between companies with any serious operations in Canada would trigger the pre-notification requirement.

The pre-notification rules apply notwithstanding that there may be no substantive competition issues in the merger. Similarly, the substantive merger review rules apply whether the transaction falls above or below the pre-notification thresholds.

For the purpose of simplicity in illustrating the pre-notification thresholds, we assume a share-purchase transaction. The prenotification rules apply, with appropriate modifications, to asset acquisitions, amalgamations and combinations, as well.

For a transaction to be pre-notifiable, the parties to the transaction (being the person or persons who propose to acquire the shares, and the corporation the shares of which are to be acquired), together with their affiliates (being all firms with a 50%+ voting share linkage up and down the chain) must have:

Aggregate: (i.e., both sides and all affiliates) gross assets in Canada that exceed C$400 million in value, as shown on their audited financial statements for the most recently completed fiscal year (which must be within the last 15 months);

or

Aggregate: gross revenues from sales in, from or into Canada, that exceed C$400 million, for the most recently completed fiscal year as reflected on the said financial statements;

and

The party being acquired must have gross assets in Canada, or gross revenues from sales in or from Canada, exceeding C$70 million on the said financial statements.

For a share transaction, acquisition of shares enjoying up to 20% of the votes cast to elect the board of directors in a publicly traded company, or shares enjoying 35% of the votes in a private corporation, will not be subject to pre-notification regardless of the size thresholds. When the 20% or 35% threshold is exceeded, and again when the 50% threshold is exceeded, prenotification is required.

If the transaction is pre-notifiable, then to close the transaction one must either submit the requisite pre-notification forms and allow for the expiration of the 30-day waiting period,8 or request and receive an Advance Ruling Certificate exempting the transaction from pre-notification. Receipt of an Advance Ruling Certificate can often take two weeks or longer, even in cases where there is no substantive competition issue.

Practitioners must keep the pre-notification regime in mind, particularly in international acquisitions, because completing a pre-notifiable transaction without providing notice is a criminal offence and gives rise to fines of up to C$10,000/day. Therefore, in an international insurance transaction, the Canadian Competition Act notification (and perhaps other Canadian regulatory approvals, including Investment Canada Act approval) is an important item on the checklist.

V. Large Company Review

Finally, there are special requirements for mergers or acquisitions of large insurance companies. If an insurance company has equity of C$2 billion or more, the company is generally required to list for trading on a Canadian stock exchange, within three years of the C$2 billion of equity being attained, shares carrying at least 35% of the voting rights of the corporation and not beneficially owned by a major shareholder of the company.9

If a large life insurance company owned by its policyholders (a mutual company) converts into an insurance company with publicly traded shares (a "converted company"),10 the Insurance Companies Act prohibits a person or entity from holding more than 20% of a class of voting shares or 30% of a class of nonvoting shares,11 except in certain restricted circumstances or with the permission of the Minister of Finance.12 The Insurance Companies Act also prohibits a single entity from having direct or indirect control over a converted company, except with Ministerial consent.13

If a converted company seeks to merge with another converted company or with an insurance company, the companies will need to follow the procedure set out above, in Section II of this article. If the Minister of Finance previously granted a Ministerial exemption permitting share ownership in excess of the 20% or 30% limit noted above, on application for a merger the Minister will consider the effect of the merger on the supervision and regulation of the amalgamated company and any of its affiliates.14

VI. Conclusion

The acquisition of insurance companies in Canada is subject to various reviews, including but not limited to review under the Competition Act. If the acquirer is non-Canadian there is also likely to be an Investment Canada Act review. When planning an acquisition of a Canadian insurance company – or the assets of a Canadian insurance company – care has to be taken to ensure that transaction timelines permit these reviews be completed in a timely manner. Although such reviews, at least in circumstances where the acquisition does not adversely impact the stability of the financial system, are unlikely to create serious problems – assuming no significant antitrust concerns – the parties still must navigate through the various process and timing issues raised by applicable Canadian statues and regulations.

1 Insurance Companies Act, SC 1991, c 47, s 407. 2 Bank Act, SC 1991, c 46, s 521. 3 Insurance Companies Act, SC 1991, c 47, ss 245-250, Office of the Superintendent of Financial Institutions Transaction Instruction A Number 12. 4 Insurance Companies Act, SC 1991, c 47, s 254. 5 Insurance Companies Act, SC 1991, c 47, s 582, 611, SOR/2002-450. 6 There is a minor exception - if the minister of finance certifies to the Commissioner of Competition that a merger under the Insurance Companies Act is in the public interest, then the merger may not be challenged under the Competition Act. Thus far, the minister has never so certified a merger. 7 Merger Enforcement Guidelines, Competition Bureau, September 2004 http://www.competitionbureau.gc.ca/epic/site/cb-bc.nsf/en/01707e.html 8 There is also the possibility of delay, if the Competition Bureau requires, during the 30 days waiting period, that the parties respond to a requirement similar to a "Second Request". If a second request is issued, the time period within which the transaction may not be completed is extended to 30 days from the filing of a complete response to such request. 9 Insurance Companies Act, SC 1991, c 47, s 411, 416. 10 Insurance Companies Act, SC 1991, c 47, s 407(4). As of May 8, 2008, four companies met these criteria: Canada Life Insurance Company, Manufacturers Life Insurance Company, Sun Life Assurance Company of Canada and Clarica Life Insurance Company. 11 Insurance Companies Act, SC 1991, c 47, s 2(3), 407(4). As noted above, the approval of the federal Minister of Finance is required where a person or entity seeks to acquire or hold more than 10% of any class of shares of the company. s 8, 407(1). 12 Insurance Companies Act, SC 1991, c 47, s 407, SOR/99-129. 13 Insurance Companies Act, SC 1991, c 47, s 407.2. 14 Insurance Companies Act, SC 1991, c 47, s 250(4)(g).